2020-06-25
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Legislation to prohibit suppliers exercising termination clauses

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Posted by Caroline Benfield on 09 June 2020

On 20 May 2020 the Government published the eagerly awaited Corporate Insolvency and Governance Bill which includes measures that have been developed over a two-year consultation period and others which are going to be introduced specifically to cater for the current pandemic. It had its second and third readings in the House of Commons on 3 June 2020 and will now be considered in the House of Lords. It is expected to be fast-tracked onto the statute books by the end of June / early July.

The temporary measures which are contained in the Bill and designed to stop otherwise viable businesses going to the wall as a result of economic turmoil caused by Covid-19, include the temporary suspension of wrongful trading and restrictions on statutory demands and winding up petitions being issued against companies where the debt is unpaid for reasons relating to Coronavirus.

One of the permanent measures contained in the Bill is the prohibition on the reliance by suppliers of termination clauses in contracts for the supply of goods or services that are triggered when a company has entered into an insolvency procedure.

Supplier termination clauses

Restricting suppliers from terminating contracts with insolvent customers is an extension of the law that already applies to utility companies and other suppliers deemed ‘essential’. This measure has been introduced in order to help companies trade through a restructuring or insolvency procedure and to maximise the opportunity for rescue of the company or the sale of the business as a going concern. The new provisions allow a distressed company to continue to trade and to prevent suppliers from insisting on the payment of outstanding charges as a condition of future supply. The aim is to make affected companies a more attractive proposition to prospective buyers.  

Regardless, the termination provisions are likely to be viewed with considerable alarm by suppliers who are currently able to rely on termination clauses to extract themselves from a contract to supply goods or services in the event of a customer becoming insolvent. The CIGB inserts a new Section 233B into the Insolvency Act 1986 which effectively prohibits this reliance if a customer enters a formal insolvency procedure.

In addition, if a supplier, under the terms of their current contract, is allowed to terminate it because of an event that occurred before their customer became insolvent (such as non-payment of debts), the supplier can no longer, under the new provisions, rely on that entitlement once the customer enters a relevant insolvency process.  

However, for new breaches which happen after the insolvency procedure begins, suppliers will still be allowed to terminate. Furthermore, a supplier will be able to terminate a contract if, in the case of the company being in administration or liquidation the office holder consents, or in any other case the company consents. The court can also activate the termination if it is satisfied that continuing to supply goods and services would cause the supplier financial hardship.

Exemptions

Small suppliers are temporarily exempted and these are defined as meeting two out of three criteria relating to turnover, headcount and balance sheet. Small suppliers are temporarily exempted where the insolvency procedures occurs during the “relevant period” being the date the Bill comes into force until the later of 30 June 2020 or one month after the Bill coming into force.

Permanent exclusions from the prohibitions applied to contracts for the supply of goods and services to a company in the context of financial services, insurance and banking and details of the same will be provided in a new schedule 4ZZA to the Insolvency Act 1986.

What suppliers can do now 

The new provisions will apply where the insolvency procedure commences on or after the day on which the provisions comes into force and they will apply in respect of contracts entered into before as well as after that date.

Suppliers should review their contracts. If your termination clauses allow for grounds, other than insolvency, to terminate and you are concerned about your customer’s ability to pay, it is worth considering using those grounds to terminate if feasible. Failure to do so will mean that if your customer enters an insolvency procedure, you will not be able to terminate on any pre-existing ground, until the insolvency procedure is at an end. Trading conditions are difficult across all sectors at the moment and most companies will be anxious to preserve good relationships with their customers for the long term. These new provisions, although designed with the best of intentions, will have suppliers nervously watching for signs of failure so they can take pre-emptive action rather than find their cashflow severely compromised.

About the author

Caroline advises on all aspects of contentious and non-contentious personal and corporate insolvency matters.

Caroline Benfield

Caroline advises on all aspects of contentious and non-contentious personal and corporate insolvency matters.

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